April 2018 Letter

Blocking and Tackling


Ever heard of Riot Blockchain?  No?  Neither had we or anyone else for that matter until last fall when a little known penny stock named Bioptix changed its name to Riot Blockchain amid the meteoric run up in the price of Bitcoin.  The result was stunning.  Riot Blockchain’s market capitalization rocketed from under $25 million to over $425 million in less than three months.  This, for a company with essentially no revenues or business model and funding of less than $20 million.  And Riot Blockchain was hardly alone.  Former beverage seller, Long Island Iced Tea, saw a similar jump in share price when it changed its name to Long Blockchain.  The list goes on as “investors” chased a fad with little regard for company fundamentals.  Lost in the Bitcoin hype, however, is the fact that blockchain is a real technology that may emerge as the transformative backbone of recordkeeping for industries ranging from healthcare, to transportation, to financials.  In this letter, we’ll skip over the hype and take a closer look at the technology and what it means for real investing in the future.

Blockchain: Simplifying Recordkeeping

To better understand the promise of blockchain, it helps to know what the underlying problem is that blockchain seeks to fix: antiquated, highly inefficient, systems of transaction record keeping. Until now, the various parties to a transaction all maintained their own in-house ledger used to track and verify transactions in which they participate.  Multiple third parties involved in a transaction with multiple record ledgers, some on differing standards, increase the time and cost of verifying terms of a given transaction, while creating needless redundancies.  Additionally, with records kept at multiple ledgers, security is more easily compromised by incursion into one party exposing other parties who may be connected to that ledger.  The blockchain solution is simplistically outlined in the diagram below.  Instead of multiple ledgers (on the left) going in multiple directions, with multiple points of access, blockchain seeks to securely centralize this information into one common ledger.    

Proponents of blockchain promise that this system, built on the consensus of all participants, will ensure a record’s provenance (complete history), immutability (tamper proof), and finality (definitive word).

Building Blocks

Blockchain is actually a very basic idea, group any number of transactions or records together in a “block,” timestamp and number the block, and link it to the next block, creating an impenetrable “chain.”  Changing information in a block becomes impossible without changing all of the contents of every preceding block.  Linking the blocks is accomplished through a process called hashing.  Hashing uses mathematical algorithms to turn a block’s data into a unique identifier, typically 32 characters long.  This becomes the block’s fingerprint that is transferred to the next block.  Participants, given access to a chain, can then look into a block and confirm a record’s validity.  For example, if a title to a home is in a block, banks, insurers, realtors, and assessors, could all have immediate access to the same, secure record, thus speeding up the title transfer process.    

Blockchain for the Real World

Large organizations, across many industries, are examining how blockchain can improve the security and efficiency of their data networks.  But before there is widespread adoption, blockchain participants need to solve three key priorities as recently cited by Michael Santomassimo, CFO of BNY Mellon: the need for standardized protocols, regulatory guidelines, and a strong business case.  To that end, many industries are establishing alliances to address these issues.  For example, in transportation, the Blockchain in Transport Alliance (BiTA) has been established to bring together industry leaders from technology, carriers, banks, shippers, and brokers to create blockchain standards for the trucking industry.  The trucking industry alone has identified multiple potential blockchain applications, including inventory management and tracking, vehicle maintenance, capacity management, payments and pricing, and fraud detection and theft prevention.  FedEx recently joined BiTA and has launched a pilot program using blockchain to examine dispute resolution.

Healthcare, where some records are still kept on paper, is another industry ripe for change.  Here, industry participants have identified applications ranging from drug supply chain integrity, claims and billing management, and centralized medical research data.  Over half of the healthcare executives recently polled by IBM expect to implement at least one commercial blockchain solution by 2020.  In fact, just last year, UnitedHealth Group hired its first Director of Blockchain Development.   

The financial industry could ultimately see the most upheaval from blockchain.  At the core of blockchain is the ability to bypass the intermediary and let the network establish validity or trust, heretofore, a bank’s main job.  Jamie Dimon, CEO of JPMorgan Chase, once said “Silicon Valley is coming,” and he’s right.  Billions of dollars are flowing into startups seeking to use blockchain to upend traditional lending and payment practices.  Responding to the challenge, though, is R3, a consortium of over 100 financial institutions, banks, and regulators that has developed and launched Corda.  Corda is an open source blockchain project designed as a distributed ledger platform built specifically for financial services.  Industry incumbents will continue to need to invest to keep pace with the disruptive changes blockchain promises. 


Here is the rest of the Riot Blockchain story; the stock has slumped back below $8 and the company is mired in accusations and investigations surrounding the validity and accuracy of its financial filings with the S.E.C. and insider stock sales made shortly after the name change as the stock was rising.  Riot Blockchain is a cautionary reminder to investors to do your homework or have a professional do it for you.  And make sure your professional is doing their homework.  At the end of December 2017, passive mutual fund advisor, Vanguard, owned nearly 300,000 shares of Riot Blockchain.    

Our approach to blockchain will be to continue to monitor and better understand its development and where it’s being deployed.  We know many of our companies will be investing directly in possible applications that will increase efficiency, reduce costs, and try to stay ahead of the competition.  We also know that many of our companies will be direct beneficiaries of blockchain spending, particularly many of our technology holdings, including semiconductor, software, and consulting companies.  WinterGreen Research estimates blockchain spending will grow from under $1 billion last year to at least $60 billion by 2024, and already some major players are jockeying for position as early leaders.  That’s where we’ll look.  We’d rather invest in companies that sell the picks and shovels and let others speculate in the crypto-currency miners, real or imagined.